Sunday, November 08, 2009

Life insurance securitization

It seems the next bubble could be “life insurance securitization”. The idea is to buy other people's life cover, that maybe they would otherwise let lapse. So you then collect on the insured, face-value payout.

This will lead to problems. When setting premium levels, insurers factor-in the likelihood that the policy will not be maintained up to the point of a claim. This helps them cut the premiums in what can be a very competitive market, especially in term (limited-period) assurance. If insurers find that securitization leads to more policies qualifying for a claim, it will mess up their calculations and they will have to up premiums for similar new policies.

There is also a strong chance that existing policies that do not have fixed,"guaranteed premium" rates will be reviewed and repriced upwards. This won't help already cash-strapped households hang on to a vital part of their financial safety net.

Many policies are already being repriced because of the underperformance of insurance companies' investments in recent years, so overall it looks like a bad trend could develop in life assurance costs and consumer uptake.

There are other dangers, as UK investors in some Keydata Investment Services products have discovered. Their "Secure Income Bond" suite of investments was based on securitized "key employee" term assurance and following a tax investigation into their legal documentation, the plans were disqualified from certain exemptions. The resulting retrospective tax charge was laid at Keydata's door, and busted them. The incoming administrators, PriceWaterhouseCoopers, have found £100 million of underlying assets are now "missing". The situation is further complicated by the fact that the assets of the Secure Income Bond were held by a company set up in the secretive foreign tax haven of Luxembourg. Britain's Serious Fraud Office has been called in, and investors now await a ruling this week by the Financial Services Compensation Scheme as to whether they will be reimbursed for losses in what was supposed to be a safe, non-stock market-related investment.

The potential is huge - the New York Times reports $26 trillion in existing life cover policies in the USA alone, of which maybe $500 billion could be in the market for securitization. And the potential damage is equally huge. Will insurance companies end up needing bailouts like the banks? Could the US economy survive a second giant hammer blow?

Look up Walmart, which took out life insurance on employees without their knowledge.

As I understand it, the insurance companies made huge sums of money in the early 90's in the dorcom market, then more recently with sub-prime mortgage securities. As a consequence, they were not very careful in their insurance pricing. Now that these markets have collapsed, they are being a little more careful. This appears to be the reason for the sudden demand for actuaries.